Securitization of sales participation certificates

ABSTRACT

The invention relates to financial products that provide a return that is a function of future sales/revenues, preferably gross sales/revenue, over a specified period of time. One embodiment of a method for creating such a financial product includes providing standard forms to an issuer and underwriter and standard terms to an issuer and investors. The terms to the issuer include providing capital to the issuer in exchange for a return that is a function of future sales over a specified period of time. The process further includes creating instruments representing investment in the financial product. The process creates the instruments in sufficient numbers and in appropriate denominations to facilitate trading in the financial product.

RELATED APPLICATIONS

This application is a continuation-in-part application of U.S. patentapplication Ser. No. 10/153,052 filed May 21, 2002 now U.S. Pat. No.8,285,626, and entitled “Securitization of Sales ParticipationCertificates,” which is a CIP of U.S. patent application Ser. No.10/131,051, filed Apr. 24, 2002 now U.S. Pat. No. 7,149,719 and entitled“Securitization of Sales Participation Certificates,” both of which areincorporated herein by reference in their entirety. This applicationalso claims the benefit of, and priority to, U.S. Provisional PatentApplication Ser. No. 60/543,983, filed Feb. 12, 2004, entitled “SalesCertificates: A New Security,” and incorporated herein by reference inits entirety.

FIELD OF THE INVENTION

The invention relates to a new type of security and, more particularly,to securities that provide a return that is a function of futuresales/revenue, preferably gross sales/revenue, over a specified periodof time.

BACKGROUND OF THE INVENTION

Large firms, can raise funds in a variety of ways including: (1)borrowing from banks; (2) issuing their own obligations directly toinvestors; and (3) issuing their obligations to an entity that in turnissues its own obligations to investors. Securitization can impact eachof these modes of raising funds and has become an efficient andinexpensive source of capital for businesses.

The parties to securities transactions are called issuers and investors.Issuers sell and investors buy and trade in securities with the help ofmarket intermediaries. Underwriters distribute securities from issuersto investors. The initial sale of securities from issuers to investorsis termed the primary market. Broker-dealers participate in, ormaintain, secondary markets in which investors trade among themselves insecurities. Tamar Frankel in Chapter 1 of Securitization, StructuredFinancing, Financial Asset Pools, and Asset-Backed Securities,incorporated herein by reference in its entirety, points out that avariety of securitized loans exist including mortgages, auto and lighttruck loans, credit card and trade receivables, computer leases andinsurance premium loans.

One can describe securitization to date as the sale of financialinstruments, representing ownership interests in, or secured by, asegregated, income-producing asset or pool of assets. The securitizationtransaction reduces or reallocates certain risks inherent in owning, orlending against, the underlying assets. The securitization transactionalso ensures that such assets are more readily marketable and, thus,more liquid than ownership interests in, and loans against, theunderlying assets.

Securities and debts are both obligations by one party to another. Aprimary distinction between securities and debts is that debts are lessamenable to trading than are securities. The form, amounts, and terms ofdebts are negotiated between the lender and borrower and, as such, donot meet the conditions necessary to create active securities markets inthem. Such markets need: 1) standard forms and terms rather thancustom-made instruments; 2) the provision of instruments in numbers anddenominations to facilitate trading; and 3) relatively low-costinformation about the underlying assets. Debts lack these attributes.

While securitization brings greater liquidity to the markets and allowsparticipants to better allocate the risks involved, many securities donot allow the investor to easily or fully inform himself as to hiscurrent financial position as determined by the securities. With respectto bonds, only the prices of on-the-run treasury bonds are readilyavailable to market participants because there are so many individualbond issues traded (on-the-run treasury bonds are recently issuedtreasury bonds), and corporate debt issues have prepayment, conversion,roll-over and other features that are difficult to evaluate. Withrespect to equity or stocks, it is a demanding task to understand theaccounting practices that generate the earnings per share figures usedto value equity securities. The Association for Investment Managementand Research (www.AIMR.com) requires members to successfully undertakeyears of courses and exams before it will award the practitioner withits Chartered Financial Analyst (“CFA”) designation. Most CFA's work forlarge money management organizations. Thus, there is a need forfinancial products that provide an investor with easily obtainable andverifiable knowledge about what the investor is buying.

SUMMARY OF THE INVENTION

The invention relates to financial products that provide a return thatis a function of future sales/revenues, preferably gross sales/revenues,over a specified period of time. As opposed to asset-backed securities,securitization in this instance represents property interest in thestream of payments representing an organization's sales or revenues.Thus, in a preferred embodiment, there are no assets segregated ascollateral for this security. One embodiment of a method for creatingsuch a financial product includes providing standard forms and terms toan issuer and to investors. The terms to the issuer include providingcapital to the issuer in exchange for a return to the investor that is afunction of future sales of the issuer over a specified period of time.

According to this embodiment, the terms to the investors arenon-negotiable and there is no asset or collateral set aside to insurerepayment of the investor's capital because the security expiresworthless at maturity. Investors investing in the financial productprovide capital to the issuer. Information about the issuer'sobligations pursuant to the above-referenced terms comes at a low-costrelative to obtaining information either about a borrower in aconventional commercial loan context or about the earnings accruing toan account of an equity investor. The process further includes creatinginstruments representing investment in the financial product. Theprocess creates the instruments in sufficient numbers and in appropriatedenominations to facilitate trading in the financial product.

Another embodiment of the invention provides a system for preparing toregister a sales participation based offering. The system includes: amemory for storing instructions; and a processor in communication withthe memory. The processor utilizes the instructions stored in the memoryfor: receiving information regarding the amount of an issue desired by apotential issuer; receiving sales information related to current salesand to sales growth rate for the potential issuer; receiving discountrate information for the issue; and calculating a function of futuresales of the issuer appropriate to service the issue. In one embodiment,the function of future sales is solely a function of future sales and isnot a function of already completed sales or receivables. In analternative embodiment, the function of future sales can be a functionof completed sales or receivables in addition to being a function offuture sales. For example, a sales certificates could provide a returnthat is a percentage of futures sales and the sales for the year thecertificate issued which could include both future sales and sales thatwere already completed at the time of issuance of the certificate.

BRIEF DESCRIPTION OF THE DRAWINGS

The foregoing and other objects, features, and advantages of theinvention will be apparent from the following description when readtogether with the accompanying drawings.

FIG. 1 illustrates one embodiment of a method according to the invention

FIG. 2 illustrates the relationship between issuers, marketintermediaries and investors in a primary market;

FIG. 3 illustrates the relationship between investors, broker/dealer(s),and possibly an exchange in a secondary market;

FIG. 4A illustrates one embodiment of a web site for generating formsfor submission to the Securities and Exchange Commission (SEC) inassociation with performing the method of FIG. 1;

FIG. 4B illustrates an example of a profit and loss statement for acompany that has raised capital using the method illustrated in FIG. 1,the profit and loss statement being a part of the web site of FIG. 4A;and

FIG. 5 is a block diagram illustrating one embodiment of a computersystem for implementing methods of the present invention;

FIGS. 6A and 6B are income statements for an issuer of debt and for anissuer of certificates, respectively;

FIG. 7A is a distribution of asset value for comparable debt andcertificate issues; and

FIG. 7B is a distribution of asset value for comparable debt andcertificate portfolios.

DETAILED DESCRIPTION OF THE INVENTION

The invention relates to a new type of security or financial product,and, more particularly, to financial products that provide returns thatare a function of future sales/revenues, preferably grosssales/revenues, over a specified period of time. Thus, future sales aredistinct from already completed sales and are distinct from tradereceivables (money that a firm currently expects to receive from alreadycompleted sales). For present purposes, this type of financial productis referred to as a securitized sales certificate or simply as a salescertificate. Also for present purposes, the term sales and the termrevenues are used interchangeably. This invention contemplates a varietyof ways of determining a firm's sales or revenues. In one embodiment,the sales or revenues are defined by sales or revenues as reported on afirm's income statements. This invention contemplates such sales reportsto be any of gross, net of promotional discounts, and/or sales that havebeen booked for which the resulting income has been, or has yet to be,received. Embodiments of the invention relate to securities that providea return that is a function of future sales as distinct from thesecuritization of trade receivables that are already on the books.

With reference to FIG. 1, one embodiment of a method according to theinvention includes providing 100 standard forms to an issuer and to anunderwriter and standard terms to an issuer and to investors. The termsto the issuer include providing capital to the issuer in exchange for areturn that is a function of future gross sales/revenues. The methodfurther includes determining 102 from the issuer, e.g., from standardforms, the amount of capital desired and calculating an appropriatefunction, e.g., percentage, of sales to achieve the desired capitalcontribution to the issuer.

Based on an appropriate function, e.g., percentage, of sales, the methodcreates 108 instruments in sufficient numbers and appropriatedenominations to facilitate trading in the underlying financial product.One embodiment of a method according to the invention, given a proposedissue amount, divides the issue amount by a fixed denomination todetermine the number of instruments. The fixed denomination is such thatthe instruments are tradable securities given the then current marketconditions. In other words, one can set the value of the fixeddenomination to reflect the denominations of other existing securities,e.g., other similar securities, in the market. For example, if the issueamount is 1 million dollars and the fixed denomination is 100 dollarsthen the number of instruments is 10,000. Approximately concurrent with,and in one embodiment prior to, the creation of instruments, the methodincludes obtaining 106 opinion of counsel, based on the standard termsand completed standard forms, hiring 110 a registrar to keep the books,and hiring 112 a trustee to collect and distribute revenues owed.Finally, the method includes conducting 114 a public or privateoffering.

Thus, one embodiment of a method according to the invention securitizesa portion of the proceeds of future gross sales/revenues, an item thatis easily audited, turning it into property that can be traded in asecondary market on an exchange, should an exchange arrange to trade inthese securities, or over-the-counter (OTC). An OTC security is asecurity that is not traded on an exchange, usually due to an inabilityto meet listing requirements. For such securities, broker/dealersnegotiate directly with one another and/or investor(s) over computernetworks and by phone.

One embodiment of a method according to the invention includes creatinga financial product by providing standard forms and terms between theissuer and the trustee who is the fiduciary representing the interestsof the investor, and between the issuer and the underwriter who is to bepaid for underwriting the issue. To clarify this point, typicallyissuers sell and investors buy and trade in securities with the help ofmarket intermediaries. In the primary market, illustrated in FIG. 2,underwriters distribute securities from issuers to investors. In otherwords, an issuer provides the issuer's obligation to the underwriter inexchange for a commitment of capital. The underwriter in turn providesthe issuer's obligation to investors in exchange for money. As notedabove, the terms of the issuer's obligations, when issuing thissecurity, include providing a return that is a function of futuresales/revenues over a specified period of time. The trustee thencollects and distributes revenues owed pursuant to the issuer'sobligations outlined in the standard forms and terms.

In the secondary market, illustrated in FIG. 3, a broker/dealer tradessecurities for money with investors. Thus, as illustrated, genericinvestor 1 can sell sales certificate(s) to a broker/dealer for moneyand generic investor 2 can purchase sales certificate(s) from thebroker/dealer for money. The broker/dealer typically prefers to end eachtrading day with no inventory, i.e., with longs equal to shorts. Inaddition, if available, the broker dealer can trade as agent forinvestors on an exchange.

In one embodiment, the terms for the security are non-negotiable by theinvestors. One achieves the creation of instruments representinginvestment in the financial product by forwarding completed/executedforms and the terms of the initial public offering to a registrar whothen keeps the books. In one embodiment of the invention, the forms andterms include instructions to the registrar as to how many instrumentsto issue to whom and in what denominations. In other words, theunderwriter instructs the registrar as part of the process of conductingan initial public or private offering (IPO) to issue sales certificatesto investors after the underwriter receives SEC approval and sufficientcommitments from investors in the IPO.

An entity, e.g., an exchange or broker/dealer, involved in trading of afinancial product according to the present invention publicizes thetrades. This publicity reduces the cost of, and enhances the transferof, information among market participants. The exchange (if there isone) or the broker/dealer involved in the trade has an interest inpublicizing the fact that it is the market for the security in question;this interest is related to the recognized phenomenon that volume intrading often leads to further volume in trading. Properly publicizedtrading prices for financial products according to the present inventionwill generate less confusion and lower transaction costs than thoseexperienced in the current bond markets. Evan Schulman and Charles Polkdiscuss transaction costs experienced in the bond markets in “Enhancingthe Liquidity of Bond Trading,” The Handbook of Fixed Income Technology,Edited by J. Rosen and R. D. Glisker, The Summit Group Press, pp.185-194, incorporated herein by reference in its entirety.

Investors want to have greater knowledge of the underlying value orearning power of their investments than what is currently available.With respect to bonds, only the prices of on-the-run treasury bonds arereadily available to market participants because there are so manyindividual bond issues traded. With respect to equity or stocks, recentreports of difficult to understand, and perhaps deceptive, accountingpractices in large publicly-traded companies demonstrate the difficultyof delivering to the investor information relevant to valuing equityinstruments. Compared to bonds and stocks, a financial product accordingto embodiments of the invention provides an investor with easier tounderstand and easier to verify information about what the investorholds or is buying or selling. Thus, using financial products accordingto embodiments of the invention, issuing firms should be able to accesscapital at a lower rate than available through conventional instruments.All things being equal between two financial products, an investor willpay more for the financial product about which the investor has greaterknowledge, since greater knowledge implies less uncertainty about therisks involved.

In one embodiment, the underwriter issues sales certificates under anOpinion of Counsel pursuant to servicing agreements between theunderwriter, trustee and the issuer. A registrar keeps the books and atrustee monitors the contract/servicing agreement and collects anddistributes the revenues owed to the investors. Keeping the booksincludes taking in the above-referenced standard terms and forms andcreating instruments, whether virtually or physically, representinginvestment in the associated financial product. The registrar followsthe transfer instructions of either the exchange, if there is oneinvolved, or the recognized broker(s)/dealer(s) and keeps track of whoowns the instruments. The trustee and registrar may be the samefiduciary entity. In one embodiment, the issuers, the broker(s)/dealers,or the exchange can instruct the registrar to use book entry to helpkeep costs down. Book entry is the name given to a process whereownership and transfer of securities occurs in the books maintained bythe registrar. No physical representation of ownership, such as stock orbond certificates is delivered to the investor.

Advantageously, embodiments of the invention ease the burden of auditingthe activity of the issuer. The investor or those acting on behalf ofthe investor, e.g., analysts, need only examine the gross sales/revenuesof the issuer. Thus, investors need no longer attempt to understand, orrely on the representations of others regarding the put and call optionsimbedded in corporate debt instruments, or the difficult to understand,and sometimes varying, accounting practices involved in determining afirm's earnings. As with all security transactions, taxable investorswill need to keep records of transactions for capital gains purposesand, depending on accounting rules, may be able to depreciate their costbasis over the life on the instrument given that, in one embodiment, itexpires worthless. By expiring worthless what is meant is that there isno repayment of principal, there are no balloon payments at maturity,and the issuer does not guarantee the investment with collateral orassets other than a guarantee of a specified function of future salesfor a period of time.

Furthermore, embodiments of the invention provide transparency oftrading, i.e., the investor can relatively easily determine the value ofan instrument. Facilitating the creation of standardized instruments insufficient quantities leads to ease of price reporting and hence thetransparency of trading. In addition, embodiments of the invention mayprovide a tax advantage to the issuer in that accounting rules may allowthe issuer to pay these obligations out of pre-tax gross sales/revenues.

Interestingly, F. Modigliani and M. H. Miller, in “The Cost of Capital,Corporation Finance and the Theory of Investment”, American EconomicReview, 48 (June) 261-97, incorporated herein by reference in itsentirety, indicate that the debt-equity mix does not affect the value ofa firm unless its tax liability is altered. This phenomenon is due tothe fact that financing, in and of itself, does not alter a firm'searnings stream or the earning stream's present value. However, theadditional transparency of the payoff from the invention's instrumentshould decrease the risks borne by investors due to the agency problemsfaced by management and the firm's accountants, and so increase thepresent value of the firm. Additionally, the instrument's expectedincrease in liquidity versus debt issues should decrease the priceconcession required to entice a buyer should the investor have to sellthe security before maturity. This increase in liquidity should alsoincrease the present value of the firm.

The invention stands in stark contrast to the opaqueness of equityearnings as exemplified in reports of recent accounting irregularitiesin large publicly-traded companies and with the involvement of at leastone large accounting firm. According to embodiments of the invention,publicly available information imbedded in a firm's disclosurestatements and the ease of auditing a firm's sales/revenue figuresregulates the sales certificates markets provided by the invention.

More explicitly, enumerated benefits of embodiments of the inventioninclude:

To the Issuer:

-   -   1.) In one embodiment, there is no repayment of principal (the        security is self-eradicating). There will be no sinking funds        and no balloon payments at maturity and there is no asset or        collateral set aside to insure repayment of the investor's        capital. Thus, according to present accounting practices, it        appears that the issue can be off balance sheet. In other words,        it appears that the firm can treat the sales certificates the        same as a lease because the sales certificates, like simple        leases, expire worthless at maturity. Sales certificates would        be visible to investors because payments to the        holders/investors of the sales certificates are a pre-tax charge        to the firm and would feature prominently in the firm's income        statement. Further, the existence of a sales certificate        liability would be indicated by a footnote reference in the        firm's balance sheet, similar to the treatment of the firm's        lease obligations. In the event that according to accounting        practices the issue cannot be off balance sheet, the issuer's        profit and loss statement simply changes accordingly.    -   2.) There is no need to give up ownership to obtain financing at        the discount rates that apply to growth vehicles.    -   3.) The firm can use the sales certificates to generate a        continuous flow of funds (capitalizing future sales), if        required. In other words, the firm can generate a continuous        flow of funds by using rollovers, i.e., by re-capitalizing        future sales as old issues expire.

To the Investor:

-   -   1.) Investors have the ability to participate in a firm's sales        directly; they no longer need to be the residual claimant. The        invention gives the investor a clearer understanding of results        of the investment.    -   2.) The investor need not evaluate the imbedded options involved        in fixed income investing: there are no call or put prepayment        features. Stated another way, corporate bond issues are        complicated financial instruments. They usually have prepayment        clauses that are really call options. The borrower can exercise        the prepayment clauses/call options to his advantage. Bonds also        represent a put option in that the borrower can put the company        or its assets to the lender when it is in the company's interest        to do so.    -   3.) According to embodiments of the invention, investors can        purchase, either directly or through pools or mutual funds that        invest in sales certificates, diversified Baskets of High        Cash-Flow vehicles (with expected growth if desired).    -   4.) Investors have the choice to concentrate their investments        by investing in (a) specific firm(s) or using sector funds that        invest in sales certificates, etc.    -   5.) Investors have available an alternative inflation hedge as        opposed to Treasury Inflation Based Securities which reflect        only the government calculated consumer price index (CPI). In        other words, if inflation occurs, gross sales/revenues may also        inflate, potentially providing investors of sales certificates        with commensurate returns.

To the Underwriter:

-   -   1.) The underwriter deals in simple standard contracts. Such        standard contracts result in lower underwriting costs than        current customized fixed income contracts.    -   2.) The underwriter enjoys a continuous flow of business due to        refinancing as earlier issues mature.    -   3.) The adoption of embodiments of the invention as a method of        raising capital provides the potential for substantial        refinancing activity.    -   4.) Sales Certificates are a complementary security and do not        supercede equity. However, Sales Certificates may change the        value of equities. Once Sales Certificates issue, the incentives        of the equity holder and the Sales Certificate holder are        aligned, if the percentage of participation is below a few        percent of sales; both holders desire increased sales. Sales        Certificates provide debt markets with competition

This invention's securitization of future sales/revenues competes withcurrently available securities, especially fixed income securities.Embodiments of the invention contemplate a standardized set of high cashflow securities that competes with the fractionalized over-the-counter(OTC) bond market. Evan Schulman and Charles Polk discuss thefractionalized OTC bond market in the above-noted article “Enhancing theLiquidity of Bond Trading,” The Handbook of Fixed Income Technology, pp.185-194

It may be argued that securities according to the invention also providecompetition for institutions that factor sales. Factoring companies(www.cfa.com) offer client firms cash for trade or sales receivables.They discount the receivables in question according to current interestrates and the risks of collecting. However, the sales the factoringcompanies discount are actual as opposed to future sales, and firmsissuing sales certificates may still use the services of factoringcompanies to collect the revenues owed.

With reference to FIGS. 4A and 4B, one embodiment of a method accordingto the invention further includes a web site and/or non web-basedsystems for issuers or underwriters to register their offerings. A website is advantageous to the extent it provides convenient, ubiquitousaccess to authorized users. However, the present invention alsocontemplates the use of non-Internet based access. Using encryption andpassword protection, the web site allows a potential issuer and/or anunderwriter to provide relevant information. The web site provides, andoptionally completes, initial public or private offering forms 116 forsubmission to the SEC. In one embodiment, the forms are SEC approved.

In the illustrated embodiment, the appropriate party, i.e., the user,enters the Issuer's Name 118, the proposed Issue Amount (e.g., inmillions of dollars) 120, the issue's Maturity or the years to Maturity122, the Current Sales of the Issuer 124 and the Underwriter Fees 126.The user then enters the Estimated Sales Growth Rate 128 and DiscountRate 130; or the user may enter the sales (absolute dollar value orpercent growth) and/or discount data by year, quarter or month.

Given this input, according to one embodiment, a program accessed viathe web site calculates the Percent of Sales 132 Required to Servicethis Issue. This is an iterative calculation (using a bisecting searchor equivalent technique) that finds the discounted percent of sales witha Present Value equal to the Issue Amount.

Should the user wish to compare the costs of this issue with standarddebt issues, they may enter the issuer's Operating Margin 134 andCorporate Tax Rate 136 along with the debt issue's Sinking FundObligations, if any. The program accessed via the web site thencalculates Profit and Loss Statements for the Issuer for the years theSales Certificates will be outstanding. One embodiment of the programcalculates three (3) profit and loss statements: one for a sinking fundbond issue, one for a balloon payment issue, and one for a salescertificate issue. The user, e.g., the underwriter, is then able tocompare the firm's cash flows under the three alternatives. The web sitecan come in a variety of forms as will be obvious to those of skill inthe art. For example, the web site may present only two profit and lossstatements: one for a sinking fund bond issue and one for a salescertificate issue as illustrated in FIGS. 4A and 4B.

Finally, if the Underwriter wishes to go ahead and file the proposedissue with the SEC, the underwriter supplies the names of the Registrarand Trustee, as previously arranged, together with their fee scale, andrequests appropriate forms. In one embodiment, the program accessed viathe web site generates appropriate forms, the blank versions of whichmay have been pre-approved by the SEC. The completed forms include theinformation input by the underwriter and the results of calculationsmade there from. The resulting forms can be in a PDF format that cannotbe altered. The Underwriter can then review them, add the Issuer'sFinancial History, Description of Business and relevant Ownership andOfficer information along with an Opinion of Counsel and file thecombined package with the SEC.

Description of Profit & Loss Statements in FIGS. 4A and 4B:

Line 1, Sales:

This is the Sales figure input by the Underwriter, grown annually by theSales Growth Rate input. (or as input by the Underwriter by year/quarteror month)

Line 3, Participation Payment:

Calculated using the result in the Required Percent of Sales calculationtimes the sales figure for the relevant year.

Line 4, Operating Costs:

Calculated using the Underwriter's assumed Operating Margin times thesales figure for the relevant year.

Line 5, Operating Profit:

Sales minus Participation and Operating Costs

Line 6, Interest on Debt:

The interest payment required to service the Issue Amount outstandingshould the Issuer have used debt to generate the Issue Amount.

Line 7, Net Before Taxes:

Operating Profit less Interest on Debt.

Line 8, Taxes:

The taxes owed using the Tax Rate supplied by the Underwriter.

Line 9, Profit:

Net Before Taxes less the Taxes

Line 10, Debt Repayment:

The amount paid to retire the Issue Amount should the Issuer have useddebt to generate the Issue Amount

Line 11, Cash Flow:

Profit less the Sinking Fund (Debt Repayment) On the right hand side ofthe statement we calculate the Present Value of the Cash Flow forcomparison purposes.

The profit and loss statement for the sales certificate accounting shownin FIG. 4B assumes that accounting rules allow the issuer to pay itssales participation obligations out of pre-tax sales/revenue. In theevent that accounting rules do not allow the issuer to do so, one wouldchange the profit and loss statement accordingly.

With reference to FIG. 5, a system 300 for executing a program accessedvia the web site of FIG. 4A and/or via a non web-based system includes abus or other communication channel 302 for communicating informationbetween components of the system. The system 300 further includes aprocessor 304 coupled to the bus 302 and a main memory, e.g., a randomaccess memory (RAM) or other dynamic storage device 306 also coupled tothe bus. The RAM stores instructions for execution by the processor 304.The main memory can also store temporary variables. The system caninclude a mass storage device 316 coupled to the bus 302 for storinginformation that is not accessed as regularly as information stored inRAM.

System 300 can include a display 308 for displaying information andinput devices such as a cursor control device 312 and a keyboard 310 forallowing a user to input data. The system can further include acommunication device 314 for communicating with other systems, e.g., aclient.

An implication of the invention is that certain non-profit institutionsmay be able to access capital markets at discount rates heretoforeavailable only to growth companies. In other words, since non-profits bydefinition are not profit oriented, non-profits have been hindered inobtaining access to capital markets to the extent that such access isdependent on producing profits. Financial products according to thepresent invention may make non-profits that have expected growth insales/revenues an attractive investment and thus provide access tocapital at appealing discount rates for those non-profits. Thus,organizations including non-profits and firms can benefit fromembodiments of the invention.

Accounting, Issuance, and Valuation of Sales Certificates

The following sections address accounting, issuance, and valuation ofsales certificates according to an embodiment of the invention. Sectionone presents accounting practice appropriate for sales certificatesfollowing recent guidance from the American Institute of CertifiedPublic Accountants. Example income statements for a firm issuing debtand for a firm issuing certificates are compared. Section two discussesa process for issuing such certificates. Section three selects a modelto adapt for valuation of sales certificates. Example distributions ofvalue for an individual and a portfolio of certificates are alsoestimated and compared to bond equivalents. Section four concludes.

1 ACCOUNTING

This section discusses the accounting treatment appropriate for salescertificates. Example income statements for a firm issuing debt and fora firm issuing certificates are compared.

1.1 Classification as Debt

The American Institute of Certified Public Accountants (AICPA) EmergingIssues Task Force (EITF) published Issue No. 88-1.8, Sales of FutureRevenues. That paper discussed the proper accounting procedures when anenterprise receives cash from an investor, and agrees to pay, for adefined period, a specified percentage or amount of the revenue, or of ameasure of income, to that investor.

According to 88-18, there are three issues concerning how to classifythe cash infusion, of which two apply to sales certificates:—whether theenterprise should classify the proceeds from the investor as debt or asdeferred income and how that debt or deferred income should beamortized. The Task Force determined that the presence of any one of thefollowing six factors creates a presumption that classification of theproceeds as debt is appropriate:

-   -   1. The transaction does not purport to be a sale (that is, the        form of the transaction is debt).    -   2. The enterprise has significant continuing involvement in the        generation of the cash flows due the investor (for example,        active involvement in the generation of the operating revenues        of a product line, subsidiary, or business segment).    -   3. The transaction is cancelable by either the enterprise or the        investor through payment of a lump sum or other transfer of        assets by the enterprise.    -   4. The investor's rate of return is implicitly or explicitly        limited by the terms of the transaction.    -   5. Variations in the enterprise's revenue or income underlying        the transaction have only a trifling impact on the investor's        rate of return.    -   6. The investor has any recourse to the enterprise relating to        the payments due the investor.        Since factors one, two and four appear to specifically apply,        the proceeds from the issue of Sales Certificates should be        treated as debt. Factor one applies because the transaction is        not a sale. Factor two applies since the issuer will be involved        in the generation of sales that determine the amounts paid to        investors. Factor four applies because the investor's rate of        return is limited by the percentage of sales and the term of the        certificates.

While FASB has not confirmed this understanding, one would expect thatthe issue would be amortized periodically using the straight-linemethod, e.g., annually. Some of the excess expense over and above theamortized amount would be deemed interest expense. To the extent thatsuch “excess” is less than the interest rate assumed and stated in theindenture when the certificates were issued, the difference should berecorded as a gain on the financing transaction for that year: to theextent that it is greater, the difference should be recorded as anadditional cost on the financing transaction for the applicable year.

1.2 Income Statement Comparison

A comparison of the accounting treatment appropriate for issuers of debtand for issuers of certificates can best be illustrated by a numericalexample (similar to the example provided above). Consider a firm withcurrent annual sales of $1,000 M seeking to raise $100 M. Assume thatthe firm's sales grow by 10% per year, and that the firm operatingmargin is 40% and corporate tax rate is 35%. Assume also that both thedebt and certificate issues have maturities of 10 years and that theissue amounts will be amortized at the rate of 10% per year.

For consistency in valuing portfolios of securities in a later section,assume the bond coupon rate is consistent with a BBB rated bond and takethe numerical value of 4.1% using Table 4 of Crouhy, M., D. Galai and R.Mark. (2000). “A comparative analysis of current credit risk models,”Journal of Banking & Finance, 24, 59-117, denoted in later sections asCGM. Although this value corresponds to a one-year forward rate, one canassume the rate is constant over the term of the issue for simplicity.

For sales certificates, the percent of sales required to service theissue is determined by the value of the issue divided by the presentvalue of sales over the term of the issue. One can assume that thediscount rate appropriate for valuing the certificate equals the bondcoupon rate so that one can make a comparison of the income statementsfor both the issuer of debt and the issuer of certificates.

FIG. 6A is an income statement for an issuer of debt. A firm withcurrent annual sales of $1,000 M seeks to raise $100 M. Annual principaland interest payments are made over ten years. Bond coupon rate equals4.1% (consistent with a BBB rated bond from Table 4 of CGM). Bondprincipal is amortized at the rate of 10% annually. Firm operatingmargin equals 40% and corporate tax rate equals 35%. FIG. 6B is anincome statement for an issuer of certificates. A firm with currentannual sales of $1,000 M seeks to raise $100 M. Certificate expires inten years and sales grow by 10% annually. Certificate discount rateequals 4.1% (consistent with a BBB rated bond from Table 4 of CGM).Certificate issue amount is amortized at the rate of 10% annually. Firmoperating margin equals 40% and corporate tax rate equals 35%. The $100M raised is 8% of the present value of future sales.

FIGS. 6A and 6B present the income statements resulting from theseassumptions. Note that the amount payable to certificate holders in anyone year, or in total, may or may not exceed the planned amortization ofthe certificate amount. When it does, the excess amount, termedparticipation, is accounted for pre-tax, analogous to debt interestpayments. However, while debt interest payments decline over the term ofthe debt as the principal is repaid, certificate participation rises assales increase. The result is that in early years, issuers of debt havelower earnings than issuers of certificates: in later years thesituation reverses. However, note that, given these income statementsuse the same interest rate for both securities, the present values ofthe pre-tax payments to the investors and the cash flow/earnings figuresare virtually identical.

2 ISSUING PROCEDURE

This section briefly discusses possible mechanics for issuing salescertificates in a cost effective manner.

2.1 Issuance

As noted above, in one embodiment a web-site generates a standardizedprospectus for such issues. The site would be available forbroker/dealers who have registered there as underwriters of SalesCertificates. Authorized underwriters enter particulars about theproposed issuer, including the amount of capital to be raised, a salesforecast, a measure of the variability of that forecast, the appropriateterm-structure of interest rates and the trustee for the issue. Theunderlying program calculates the percent of sales to be paid toinvestors given the above variables. The underwriter, after doing“what-if” analysis, uses the program to generate a standard prospectusand trustee indenture customized for this particular issuer. All thatwould need to be added to this paperwork for submission to the SEC andpotential investors is an Opinion of Counsel that the company has theauthority to issue such paper, a relevant financial history of theissuer and a Statement of Purpose as to how the proceeds will be used.2.2 Statement of PurposeThe Statement of Purpose should address the appropriate size of theissue given the current level of sales and capitalization of the firm.Demonstrating that management is growing the earnings of the firm is areasonable approach. If sales are profitable, increasing sales increasesthe stream of residuals accruing to the equity holders; however theleverage involved in issuing paper with a prior claim on revenuesincreases the volatility of that stream of residuals and thus slowstheir rate of growth. For instance, chapter 5 of Markowitz, Harry M.(1959) “Portfolio Selection: Efficient Diversification of Investments”,Yale University Press, New Haven Conn. notes that one can approximatethe compound growth rate as a function of the average growth rate less ½the variance. The financial literature provides other models that valueflows of funds given their volatility. As a minimum, both equity andcertificate investors would like to see that the financing is a rationalstep for the firm that will increase the compound growth rate ofearnings. Including such an analysis in the Statement of Purpose willhelp all concerned to avoid instances where firms over-leverage in termsof the percent of sales used to support an issue.

3 VALUATION

This section selects an approach to adapt for the valuation of salescertificates and provides example distributions of value for anindividual certificate and a portfolio of certificates and comparesthese to bond equivalents.

3.1 Model Selection

Credit risk models have also been advanced in a number of commercialproducts. CGM provides an often cited and comprehensive analysis of thecommercial credit risk products: CreditMetrics, KMV, CreditRisk+ andCreditPortfolioView. The outline of the approach for CreditMetrics alongwith a number of empirical values presented in this work will be used inthe subsequent analysis.

Longstaff, F. A. and E. S. Schwartz. (1995) in “A simple approach tovaluing risky fixed and floating rate debt,” The Journal of Finance, 50(3), 789-819, denoted in later sections as LS, develop a model forvaluing risky corporate debt using a structural approach that isappealing for the simplicity of the resulting closed form solution. Thissection adapts the LS model for valuing risky corporate debt to valuesales certificates because of its conceptual clarity and computationalutility.

3.2 Valuation Approach

This section adapts the framework developed by LS for valuing riskycorporate debt to valuing sales certificates. This section also presentsthe numerical procedure used to generate various potential outcomes forinvestors to be described in a later section.

Six assumptions underlie the LS valuation framework:

Assumption 1:

The total assets of the firm, V, exhibit dynamicsdV=μ _(V) Vdt+σ _(V) VdZ _(V)  (1)where σ_(V) is a constant and dZ_(V) is a standard Weiner process.In the present case, the return to certificate holders is determinedusing a forecast for the present value of future sales. Therefore, onecan consider the dynamics of the total sales of the firm. For anyrealization of this sales process, and based on the AICPA guidelines, anoperating profit results which, when discounted, determines the totalvalue of the firm. Assume, then, that the total sales of the firm, S,exhibit dynamicsdS=μ _(S) Sdt+σ _(S) SdZ _(S)  (2)where σ_(S) is a constant and dZ_(S) is a standard Weiner process.Assumption 2:The short-term riskless interest rate, r, exhibits dynamicsdr=(ζ−βr)dt+ηdZ _(r)  (3)where ζ, β and η are constants and dZ_(r) is also a standard Wienerprocess exhibiting correlation ρ with dZ_(V).For adapting the LS framework for valuing sales certificates we assumedZ_(r) exhibits correlation ρ with dZ_(S). LS note that these interestrate dynamics are consistent with the Vasicek (1977) model for the termstructure and are adopted to enable closed form solution. Since anumerical method will be required here to accommodate the firm valuationprocedure, other interest rate dynamics could be used without increasingcomputational complexity. The interest rate dynamics originally adoptedby LS were retained to allow their closed form solution to be used tovalidate the numerical solution for debt issuers.Assumption 3:The value of the firm is independent of the capital structure of thefirm.LS note that this assumption simply means the Modigliani-Miller Theoremholds. The approach followed here is consistent with this assumption.However, for sufficiently small discount rates, the difference inaccounting between debt and certificates in our spreadsheet example willlead to slightly differing operating profits and hence, afterdiscounting, slightly differing firm values.Assumption 4:Financial distress occurs immediately when the total assets of the firmreach a threshold value.Financial distress can occur in a firm issuing sales certificates, ofcourse, as it can for debt. For example, sales may provide insufficientcash flow to meet current obligations, including payments to certificateholders, or sales may provide insufficient working capital. Noadjustment is made in the present models for the fact that, becauseSales Certificates require no fixed payments, the incidence ofbankruptcy should be less than when using standard debt instruments.Assumption 5:Reorganization follows financial distress resulting in a write-down inthe value security holders receive.Recovery rates for corporate bond holders during reorganization havebeen well studied. Of course, no data is available to study the recoveryrates of firms that have issued sales certificates and defaulted. Inorder to facilitate the comparison between issuers of debt and issuersof certificates, one can assume that the same recovery rate applies foreach. LS note that there is no reason to assume that the recovery rateis constant. One can assume it is drawn from a normal distribution usingmean and standard deviation from CGM.Assumption 6:Perfect, frictionless markets in which securities trade in continuoustime.This assumption is required in the LS framework so that standard resultscould be used to derive the price governing partial differentialequation. The numerical solution technique employed in our model makesthis assumption unnecessary.The framework adapted to this point applies for an individual firm. Inorder to consider a portfolio of firms, we must account for theempirical observation that default of one firm is correlated to thedefault of other firms. The correlation occurs due to the common effectsof the macroeconomic environment and due to financial dependenciesbetween firms. The valuation framework can be extended to this case byassuming that the total sales of firm i, S_(i), exhibit dynamicsdS _(i)=μ_(i) S _(i) dt+σ _(i) S _(i) dZ _(i)  (4)where σ_(i) is a constant and dZ_(i) is a standard Weiner process. Werefer to the covariance matrix relating dZ_(i) and dZ_(r) for all i asΣ.3.3 SolutionThe solution procedure begins by assuming an interest rate spread andaverage cumulative default rate consistent with the credit rating of thefirms in the portfolio: the spread and average cumulative default rateare the same for issuers of debt and issuers of certificates. A baselinevalue of the firm is determined using a forecast of sales and theappropriate accounting treatment. The level of sales required to servicethe certificate issue is determined using these baseline values, therisk-free interest rate, and the appropriate spread. Thresholds fordefault are determined assuming a normal distribution and using averagecumulative default rates and baseline firm values. Random paths aregenerated for the sales of each firm and for the underlying risk freeinterest rate. The covariance structure is enforced by post-multiplyingeach vector of innovations by the Cholesky decomposition of thecovariance matrix Σ. The debt or certificate is revalued using thecurrent sales and interest rate path with the appropriate spreads andcompared to the default threshold. If default occurs, the security valueis written down. Repetition of this process over many paths leads to adistribution of ending values for the issue (see FIG. 7A), or portfolioof issues (see FIG. 7B).3.4 Example Distributions of ValueAgain, a comparison of the distribution of security value for issuers ofdebt and for issuers of certificates can best be illustrated by anumerical example. Consider a portfolio of firms each with currentannual sales of $1,000 M and each seeking to raise $100 M. One canassume each firm issuing debt structures the bond so that annualprincipal and interest payments are made over ten years. One can assumethe portfolio of firms is selected so that bonds having a rating of AAA,AA, A, BBB, BB, B, and CCC are represented. One can chose spreads andaverage cumulative default rate using values from Table 2, 4 and 6 ofCGM. One can assume that all certificate issues will expire in ten yearsand the discount rate appropriate for valuing all certificates equalsthe corresponding bond coupon rate so that a comparison of the securityvalue for the issuer of debt and the issuer of certificates can be made.Assume that all debt and certificate issue amounts will be amortized atthe rate of 10% annually and that the operating margin is 40% and thecorporate tax rate is 35%, for all firms.

Parameters defining the sales and interest rate dynamics must also bespecified. Assume that the sales drift rate is 10% annually and that theannualized volatility of sales is 20% for all firms. Assume that thelong-run risk free interest rate is 3% with a mean reversion factor ofunity and annualized volatility of 3%. The correlation between sales ofeach firm is 0.6 and between sales and the short-term risk-free interestrate is −0.3. When default occurs, draw a write-down value from a normaldistribution with mean of 35.82% and standard deviation of 23.81% basedon Table 6 of CGM and corresponding to senior subordinated debt.

FIGS. 7A and 7B illustrate the resulting distributions for an individualBBB rated security and for an equally weighted portfolio of securities.Note that the distribution of debt value exhibits the expected long tailon the downside, while the distribution of certificate value exhibits abroader distribution with a longer tail on the upside.

FIG. 7A is a distribution of asset value for comparable debt andcertificate issues. A firm with current annual sales of $1,000 M seeksto raise $100 M. Bond annual principal and interest payments are madeover ten years. Bond coupon and certificate discount rate equals 4.1%(consistent with a BBB rated bond from Table 4 of CGM). Averagecumulative default rate equals 4.34% (consistent with a BBB rated bondafter ten years from table 2 of CGM). Certificate expires in ten years.Bond and certificate issue amount are amortized at the rate of 10%annually. Firm operating margin equals 40% and corporate tax rate equals35%. Sales drift rate equals 10% annually and annualized volatilityequals 20%. Long-run risk free interest rate equals 3% with a meanreversion factor of unity and annualized volatility of 3%. Correlationbetween sales and the short-term risk-free interest rate is −0.3.Write-downs are drawn from a normal distribution with mean 35.82% andstandard deviation 23.81% (consistent with senior subordinated date fromTable 6 of CGM). FIG. 7B is a distribution of asset value for comparabledebt and certificate portfolios. All firms have current annual sales of$1,000 M and seek to raise $100 M. Bond annual principal and interestpayments are made over ten years. Bond coupon and certificate discountrates equal 3.60%, 3.65%, 3.72%, 4.10%, 5.55%, 6.05%, and 7.53%(consistent with a AAA, AA, A, BBB, BB, B, and CCC rated bond from Table4 of CGM). Average cumulative default rates equal 1.40%, 1.29%, 2.17%,4.34%, 17.73%, 29.02%, and 45.10% (consistent with a AAA, AA, A, BBB,BB, B, and CCC rated bond after ten years from Table 2 of CGM). Bondsand certificates expire in ten years. Bond and certificate issue amountsare amortized at the rate of 10% annually. Firms' operating marginsequal 40% and corporate tax rates equal 35%. Sales drift rate equals 10%annually and annualized volatility equals 20%. Long-run risk freeinterest rate equals 3% with a mean reversion factor of unity andannualized volatility of 3%. The correlation between sales of each firmis 0.6 and between sales and the short-term risk-free interest rate is−0.3. Write-downs are drawn from a normal distribution with mean 35.82%and standard deviation 23.81% (consistent with senior subordinated datefrom Table 6 of CGM).

4 CONCLUSIONS

Sales certificates are a new type of security providing a return that isa function of a firm's sales over a specified period of time in thefuture. Investors benefit from this new security by gaining a clearerunderstanding of the process that generates their investment returns.AICPA rules determine that the proceeds from the issue of salescertificates should be treated as debt since a periodic percent of saleswill be paid to investors and the issuer will be involved in thegeneration of sales, and because the investor's rate of return islimited by the specified percentage of sales and the term of thecertificates. A structural approach for valuing sales certificates isdeveloped by adapting the LS model for valuing risky corporate debt. Thedistribution of value for sales certificates, or a portfolio of salescertificates, is broader than the distribution of value for comparabledebt, or a portfolio of debt issues, and exhibits a significantly longerupside tail.

Having thus described embodiments of the invention, various alterations,modifications and improvements will readily occur to those skilled inthe art. Such alterations, modifications and improvements are intendedto be within the scope and spirit of the invention. Accordingly, theforegoing description is by way of example only and is not intended aslimiting. The invention's limit is defined only in the following claimsand the equivalents thereto.

What is claimed is:
 1. A computer-implemented system for preparing toregister a sales participation based financial product offering, thesystem comprising: a computer-readable storage device for storinginstructions; and a processor in communication with thecomputer-readable storage device, the processor operative to utilize theinstructions stored in the computer-readable storage device for:receiving information regarding the amount of an issue desired by apotential issuer; receiving sales information related to current salesand to sales growth rate for one or more organizations; receivingdiscount rate information for the issue; setting a function of futurereported sales of the one or more organizations using the desired issueamount information and a present value of estimated future sales of theone or more organizations in setting the function, the present valuebeing based on the sales information and the discount rate information,the function being configured to later determine an amount to be paid toinvestors based on the future reported sales of the one or moreorganizations; and determining a number of tradable instrumentsrepresenting investment in the financial product, the act of determiningcomprising: receiving a fixed denomination for the tradable instruments;and dividing the issue amount by the fixed denomination to determine thenumber of tradable instruments.
 2. The system of claim 1, wherein theone or more organizations comprise a combination of organizations thathave combined to sell claims on their joint future reported sales. 3.The system of claim 1, wherein setting the function of future reportedsales comprises using historical growth rates for sales.
 4. The systemof claim 1, wherein the discount rate information comprises a discountrate that is mutually agreed upon by the issuer and the investors inlight of prevailing market conditions.
 5. The system of claim 1, whereinthe function of future reported sales is a linear function.
 6. Thesystem of claim 1, wherein the financial product expires worthless atmaturity.
 7. The system of claim 1, wherein setting a function of futurereported sales comprises setting a function of future reported salesover a specified period of time.
 8. The system of claim 1, wherein thefuture reported sales comprise at least one of: the future reportedsales of the one or more organizations; the future reported sales of asubsidiary of the one or more organizations; and the future reportedsales of a division of the one or more organizations.
 9. The system ofclaim 1, wherein setting a function of future reported sales comprisessetting a function that is a function solely of future sales.
 10. Thesystem of claim 1, wherein setting a function of future reported salescomprises setting a function that is a function of future sales andalready completed sales.
 11. The system of claim 1, wherein the futurereported sales of one or more organizations are defined by sales asreported on an income statement of each of the one or moreorganizations.
 12. The system of claim 1, wherein the one or moreorganizations comprise the issuer.
 13. The system of claim 1, whereinthe processor is operative to utilize the instructions stored in thecomputer-readable storage device for calculating a present value ofestimated future sales using an iterative calculation.